In my previous blog, I laid out the case for business owners to save hundreds of thousands of dollars by funding their business continuity through life insurance. The following is a case study of what happens when there is no planning and no life insurance.
It had been 5 years since I had seen a former coworker, Jen. She was in her mid-30’s when she left the company I was working at, and had started a pizza restaurant with a family friend who was 15 years her senior. He owned 51%, she 49%. Now, Jen looked like she was in her 50’s. I asked her how her restaurant was. I knew it was next to the campus of a big university—25,000 students. “Busy,” she said. “Too busy.”
“Great!” I said. It must be nice to have a place that is so successful.
“Not really,” she said. Then she explained. Her partner had a heart attack and died 2 years before. He was the kitchen manager. She was the business manager. Now she had to do it all, and was working 70 and 80-hour weeks.
“Why don’t you just hire someone to be the kitchen manager?” I asked.
“I can’t,” she said. “I don’t have enough funds.”
“Wait a minute. I thought you said the restaurant was doing very well.”
“It is. But Joe was married, and his wife is now my partner. She’s not doing any of the work, and expects half of the profits. She got a lawyer, and I fought it in court for a while, but I’m stuck with her. So I’m doing my job, Joe’s job, or now his wife’s, and I’m only getting half the profit. I’m stuck.”
This encounter with a former coworker demonstrates a common example of the often-ignored need for business continuity planning. People go into business because they’re good at something, and don’t’ think to make plans for the business to survive them or their partners. And they end up in a bad situation.
Facts are, businesses represent the major asset for business owners and their families. Jen had put a lot of money into the business, as had Joe. It was her only source of income. It represented her largest asset as well. Furthermore, I guess I couldn’t blame Joe’s wife for wanting to hang onto the business. She essentially had no job skills, and the restaurant was her meal ticket. She was entitled as Joe’s survivor. But the lack of a plan left Jen in a world of hurt.
What were Jen’s options at this point? She could just walk away, but she would be liable for half of the businesses debts. This would cost Jen hundreds of thousand of dollars.
The business could be sold. Jen wouldn’t get nearly what she had invested for the restaurant equipment. I don’t know how she would have fared on the sale of the commercial space. But it could have taken a lot of time to sell it. Plus there’s the cost: broker’s fees, etc. There might even be a legal dispute between her and Joe’s wife. Besides, she was now the majority shareholder, which left Jen in a vulnerable position. So again, this decision might cost Jen tens or hundreds of thousand of dollars.
A third option would be for Jen and Joe’s wife to come to terms of a buy out agreement. Then Jen might be able to borrow the money to pay her new partner off. But again, it’s a long a complicated process to properly evaluate a business and complete the sales process. This process costs thousands of dollars and takes time. What would happen to the profitability of the business while Jen and Joe’s wife and fighting over that? Would there be much left to run? Furthermore, the cost of borrowing the money for the buy out would be substantial. Tens of thousands in interest. And even after that happened, Jen would not be in a position to hire a kitchen manager. She would have the additional overhead of the loan to service. She would have to run the whole show herself for some time afterward.
Jen had no good options. None that weren’t very costly either.
I didn’t go into the “why didn’t you” mode with her. It was water over the dam. But I was thinking it. A business continuity plan, and life insurance on each partner, would have been by far the cheapest and most effective solution, had Jen and Joe done it when they started the partnership and the business.
Here’s how it could have worked. Jen and Joe start the business, and each buys a life policy on the other, in the amount that represents their share of the value of the business. Say the business is worth $750.000. Jen would buy a life policy on Joe for $382,500. Joe would buy one on Jen for $367,500. That way, if the other dies, the survivor would buy out the survivor’s beneficiaries with the proceeds. Of course, this would have to have what’s called a “Buy-Sell” agreement in place too. The other thing is that both Jen and Joe would need to re-evaluate the value of their business regularly to keep the agreed to purchase price current.
The cost for all this? When I ran illustrations for a “What If” scenario, I came up with $529.00 for Jen and $1604.00 for Joe at the age they were when they started the business. That’s a little over $2100.00 a year.
Clearly, life insurance to fund business continuity plans is always the least expensive option financially. And, as we can see from this case, it is also the least expensive emotionally.